After all the pre-budget talk of reducing tax relief on pensions, the government has introduced “bonuses” on ISAs available from April 2017. But what does this mean? And how does it compare to a pension?
What is a LISA?
- You can save up to £4,000 a year into a LISA
- At the end of the tax year the government will add a 25% bonus to the LISA based on contributions in that tax year e.g., if you save £1,000 you’ll receive a £250 bonus, if you save the full £4,000 you’ll receive a £1,000 bonus
- Bonuses are paid from age 18 to 50
- Anyone aged over 18 and under 40 can open an account
- The £4,000 will be counted against the annual ISA savings allowance – £20,000 (as at 2017/18 tax year). If fully subscribing, the remaining £16,000 will not receive bonuses
- The Lifetime ISA is designed for two specific purposes:
- for first-time buyers to use towards a residential property,
- To take out and use in retirement after age 60
Using the LISA to save for retirement
The LISA can be accessed from age 60
- It doesn’t have to be taken all at once and partial withdrawals can be taken
- Withdrawals from a LISA are all tax-free
There are penalties if the money is taken before 60 and is not used to purchase a first home:
- the government bonuses will be lost along with any interest that these have accrued
- There will be a 5% penalty on the amount withdrawn
It’s a horrible circumstance, but there is a provision in the Lifetime ISA rules that allows you to access the cash as a tax-free lump sum if you’re terminally ill, provided that you have 12 months or fewer to live.
If you die, and you’re married or have a civil partner, your Lifetime ISA allowance passes to him/her to invest your Lifetime ISA savings as well as their own. This is on top of their usual ISA allowances.
However, the funds in the Lifetime ISA do form part of the estate for inheritance tax purposes.
Pensions Vs LISA
So, how does a LISA compare to a pension:
- Auto Enrolment means for the employed, employers have to make minimum contributions into a pension on employees’ behalf. They don’t have to do so into a LISA.
- Higher-rate taxpayers get tax relief at 40% on contributions into a pension
- LISAs can affect your benefit entitlement whereas pensions do not
- Money can be taken from a pension from age 55; the minimum age is 60 to withdraw from a LISA without penalty.
- Money invested in a pension is outside of the estate for inheritance tax (IHT) purposes whereas money within a LISA will form part of an individual’s IHT allowance (the IHT threshold is currently £325,000)
- 100% of your earned income or £40,000 per annum (whichever is lower) can be paid into a pension each year and receive tax relief
- Business owners can make payments into their pensions as a business expense – they cannot into LISAs
- On bankruptcy, Pensions cannot be taken to pay creditors whereas ISAs can
- Tax relief is applied to pension contributions immediately whereas with an LISA, the bonus is not received until the end of the tax year
- Pension contributions paid via salary sacrifice into an employer scheme, are not be subject to national insurance this is not the case with a LISA
- On taking money out of a pension, 25% of it is tax-free– the rest is taxed as income. Money can be withdrawn entirely tax-free from a LISA. Having said that, the tax rates on pensions, encourage individuals to take it as income so that they do not breech tax bands thus providing retirement income
- The LISA is more flexible with the option to withdraw the money before age 60 (with penalties) but again will this mean that individuals may not make adequate retirement provisions if they are tempted to withdraw their money before age 60?
- Apart from with critical illness and death money cannot be withdrawn from a pension early, but if prepared to pay a 5% penalty money can withdrawn from a LISA.
So, is this the start of a new pensions ISA? Is the LISA the new way to plan for retirement? It could form part of your plan and it’s a good idea to have a plan for retirement!
The information contained within this document is correct as at 2016/17 tax year and is based on current government legislation. This can change.
Author: Alice Douglass, Grosvenor Consultancy Ltd
There are advantages and disadvantages to using all of these strategies and they depend on individual circumstances so don’t take action without seeking competent advice. Tax rules, rates and allowances are all subject to change. The Financial Conduct Authority does not regulate tax advice and some forms of offshore investments. The value of investments and the income from them can fall as well as rise and you may not get back the full amount you invested.
The information contained within this document is correct as at 2015/16 tax year and are based on current government legislation. These can change.
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